PhillipCapital has initiated coverage on OUE LJ3 REIT, calling it a “50% discounted investment-grade REIT” with upside potential from asset enhancements.
In a June 24 note, research head Paul Chew and analyst Liu Miaomiao note that OUE REIT has “the largest discount” to net asset value (NAV) among S-REITs rated “investment grade”, at 0.43x P/NAV. OUE REIT also boasts an “attractive” yield of 7.8%, they add.
Starting OUE REIT at “buy” with a 33-cent target price, 27% above its last close price of 26 cents, Chew and Liu say the NAV discount is “not warranted”. “Around 92% of the portfolio is in Singapore with resilient occupancy rates and rental growth.”
OUE REIT is one of Singapore's largest diversified REITs, say the analysts, with assets totalling $6.3 billion as of December 2023. Its assets are OUE Bayfront, One Raffles Place, OUE Downtown Office, Mandarin Gallery, Hilton Singapore Orchard, Crowne Plaza Changi Airport and Lippo Plaza in downtown Shanghai.
Upside potential from AEI and repositioning
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Chew and Liu see upside potential from asset enhancement initiatives (AEI) and repositioning, with downside protected by the master lease.
Hilton had its full contribution in FY2023 after repositioning from Mandarin Orchard, focusing more on business travellers with a target on US customers, thereby increasing revenue per available room (RevPAR) by 27% after rebranding.
“We forecast RevPAR to grow by 11% for Hilton in FY2024, given the continued recovery of visitor arrivals and limited new supply,” they note. “Meanwhile, Crowne Plaza also completed its AEI in October 2023. The master lease agreement ensures a minimum rent of $67.5 million, supporting a group yield of about 6%.”
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Hilton is leased to OUE Limited under a master lease agreement with an initial term of 15 years starting from July 2013, and an option to renew for an additional 15 years. Crowne Plaza is also leased to OUE Airport Hotel Pte. Ltd. under a master lease agreement until May 2028, with an option to renew for two consecutive five-year terms.
The master lease agreements consist of both a fixed rent component and a variable rent component. Variable rent for Hilton comprises a sum of 33.0% of gross operating revenue (GOR) and 27.5% of gross operating profit (GOP), subject to a minimum rent of $45.0 million.
For Crowne Plaza, variable rent comprises the sum of 4% of hotel F&B revenues, 33% of hotel rooms and other revenues not related to F&B, 30% of hotel GOP and 80% of gross rental income from leased space, subject to a minimum rent of $22.5 million.
OUE REIT has been enjoying downside protection since Covid-19, and the variable component just surpassed the minimum level in 2023, reaching $91.6 million. Thus, Chew and Liu “believe the two hotels will continue performing going forward”.
High rental reversion
Chew and Liu expect high rental reversion to sustain in FY2024. OUE REIT managed to secure high rental reversions of 12.0% for office and 13.7% for retail in FY2023. This momentum is expected to continue in FY2024 at 10%, say the analysts.
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“We believe the new office supply will not place significant rental pressure, as asking rents are higher than the office properties owned by OUE REIT. While rental reversion for Lippo Shanghai may still be negative, given its small revenue exposure of 7.7%, we believe the effect on the overall portfolio will be marginal.”
Attractive, investment-grade dividend yield
OUE REIT obtained an “investment grade” rating by S&P in 2023. Compared to the nine other S-REITs with investment ratings, OUE REIT has a relatively healthy gearing of 38.8%, the largest discount of 0.43x P/NAV, and an attractive yield of 7.8%, say Chew and Liu.
Early in June, the manager of OUE REIT announced it had priced $250 million of green notes under its $2 billion multicurrency debt issuance programme. Chew and Liu note that this green bond issuance is at a “more favourable” rate of 4.1%, lower than the current all-in cost of debt, which was 4.5% in 1Q2024. “We do expect another year of interest rate headwinds, causing DPU to decline further in FY2024 with a recovery in FY2025.”
OUE REIT follows a distribution policy of at least 90% of its taxable income. Since its listing in 2012, it has been distributing above 92%. In FY2023, the payout ratio was 93.5%. The REIT has consistently paid out quarterly dividends.
Chew and Liu expect a DPU of 2.0 cents for FY2024 and 2.9 cents for FY2025, translating into yields of 7.8% and 11.4% respectively.
As at 11.18am, units in OUE REIT are trading 0.5 cents lower, or 1.92% down, at 25.5 cents.
